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Inflation, part 1: On shelter futures

157 points by kristianp 4y ago

01100011 4y ago
How do Canadians feel about the shorter term(5 years) available for fixed rate mortgages? I would think that shorter term would contribute a significant level of anxiety regarding one's future financial solvency.
- kevin_nisbet 4y ago
  I don’t know that I really count since I’m quite frugal. On my end I think the term mortgages are great since I believe it leads to lower overall interest rates. There’s a lot less risk that gets baked into the price that would be needed for longer terms. I know I’ve compared to other jurisdictions where interest seems way higher. So it doesn’t cause me any anxiety.
  - amscanne 4y ago
    It’s been “great” for the last forty years because rates have been consistently trending downwards. You’ve never had to think about the downside. Your experience would/will be much different in an environment where rates are rising. Regarding the upside, the rates aren’t much different in the US where you typically have 30 years locked in. Unlike Canada, these also generally have no prepayment penalty, so you can always refinance on rate drops. I’m quite sure the rates on a ARM 5 year or 8 year would be directly comparable to a Canadian mortgage (and you always have that option in the US). There’s lots of great things about Canada, but I think you’re really stretching to see a positive where there isn’t one. (I’m Canadian but I definitely don’t hold a positive view of our financial institutions.)
    - xyzzy123 4y ago
      30 year mortgages are a political guarantee to homeowners. They're don't really come from the lending industry - lenders could not and would not ever create this product on their own. They're a government subsidy to mortgagors enabled by the origination process, obscured by a few hops of financialization. You get a rate guarantee for 30 years plus you can refi, sell or walk away if the bet doesn't go your way. It's pretty much begging to be exploited.
      - barry-cotter 4y ago
        > They're don't really come from the lending industry - lenders could not and would not ever create this product on their own. I was going to quibble with this since I’ve seen fixed rate mortgages in Ireland but… > A fixed rate mortgage is a home loan for which the interest rate is kept the same for an agreed amount of time. The maximum length of time for which a mortgage can be fixed in Ireland is ten years. https://personalbanking.bankofireland.com/articles/my-first-home/looking/fixed-vs-variable-rate-mortgage/#:~:text=A%20fixed%20rate%20mortgage%20is%20a%20home%20loan,so%20what%20is%20a%20variable%20rate%20mortgage%20then%3F https://personalbanking.bankofireland.com/articles/my-first-...
        xyzzy123 4y ago
        Yes and the rates will tend to be considerably different - you will actually see a risk premium in the longer terms, as you would expect. The fact that "cheap" 30 year fixed rate mortgages only exist in a few countries (US is only one I know of, but it's a big world) is the most accessible evidence that they're created by government policy (without having to dig into the technical details of how they are originated and guaranteed).
        maxerickson 4y ago
        Living in the US, I can't imagine taking out the maximum mortgage that I theoretically qualify for. (without having done it, I think I don't like the idea of 1/2!)
        denimnerd42 4y ago
        It’s pretty easy to take out the maximum if you’re trying to buy a home without contingency on selling your previous one. Since only the monthly payments really matter towards qualification you could be 90% paid off on your first mortgage and still need to work around the DTI limit for your second. When you sell your first everything becomes comfortable again.
    - kevin_nisbet 4y ago
      I don’t think it’s fair to say I’m not aware of the downsides. Yes my own experience is universally in a very aggressive rate environment that could impact my perspective. But I’m also aware that the majority of the time variable rates end up ahead of fixed rates. The term mortgages to me make it a bit closer to variable rates. The rate gets updated every few years. Banks themselves to fund the mortgages don’t get 25 year loans. So as an institution they need to set rates based on risk so they don’t lose money. This risk increases the further you project into the future. So all other things being equal you are not paying a premium to insure against that risk. I’m not commenting on the financial institutions as a whole, or other factors that may lead to higher or lower rates. I’m under the impression that rates are a higher in the us for the 25 year mortgages when calculated off of the overnight rates from the central banks. But I don’t have any data handy to back up the impression for I could be wrong. I suppose having this be an option for the consumer is probably the best option. But for most consumers insuring against rate increases will be quite costly.
      - happyopossum 4y ago
        > But for most consumers insuring against rate increases will be quite costly. I’m not sure how you can make an argument that long and specific while completely ignoring the evidence to the south of you that contradicts it.
    - deleted 4y ago
      [deleted]
  - PragmaticPulp 4y ago
    > On my end I think the term mortgages are great since I believe it leads to lower overall interest rates. When rates are going down, yes. But locking in low rates in the United States for 30 years either at purchase time or via refinancing is one of the weirdest advantages of home ownership here. It's surreal to have a 2.x% mortgage locked in for decades when rates are quickly going up and inflation is reducing the relative value of my debt and payments.
    - pishpash 4y ago
      The only way this ends is by running the process in reverse where declining asset prices reduce the gains made on the debt side. If asset prices do not decrease in a rising rate environment, then inflation cannot be controlled. We've baked in 8% annualized real loss somewhere going forward and it will come out of somebody's pockets, but it's still being decided whether asset owners or debtors will pay.
      - chii 4y ago
        > If asset prices do not decrease in a rising rate environment, then inflation cannot be controlled the asset price could remain stable, if the jobs that service those mortgages aren't removed. Inflation of consumables can be controlled, but it is painful. Inflation of assets should not be controlled, even if it could - asset growth represents the wealth of those who invested in it. If this growth is artificially suppressed, millions would lose their retirement funds, and become poorer in the future, and for what?
        sjfidsfkds 4y ago
        Inflation means there is too much demand in the economy compared to the supply (of goods and labor). Decreased retirement funds are one mechanism by which asset price reductions can lead to people consuming less and working more. More broadly there’s a wealth effect that determines how much people spend.
        pishpash 4y ago
        Nothing is in a vacuum and wealth only has meaning relatively. As much as it may be a shock to hear, wealth is but a social contract on how much it gets you in exchange. There is no absolute answer on that and it's subject to negotiation. If you are in charge of distributing wealth (which is what this is, let's be honest), higher prices means current asset holders are favored over future asset holders who want to purchase assets. Why should those who invested in a bubble during the loosest money era be entitled to exchange it for the same amount of labor or goods of those who built wealth during austerity?
  - refurb 4y ago
    Leads to lower rates? The US 30 year fixed bottomed out at 2-2.5%, which seems about the same as the lowest 5 year fixed in Canada? When Canadians have to renew at 5-7% in a few years that’s going to cause massive havoc.
    - rnd33 4y ago
      On average over a longer period variable rates will always be lower, since the risk premium due to future rate uncertainty will be lower. If that period is a 100 years it won't help lenders much though.
      - refurb 4y ago
        Variables rates will always be lower? At any given point in time, true. But you can lock in a fixed rate that will be lower than a variable rate in the future when rates rise.
  - throwawayarnty 4y ago
    Variable rates are great until rates dramatically increase. A huge number of Canadians will not be able to afford their mortgage payments over the next 5 years because they did not calculate rate rises when buying home. Furthermore, they won’t be able to sell the home without taking a huge loss because housing prices will have plummeted due to rate hikes. Combine that with rising cost of food and gas, Canadians are in for a wild ride.
    - nemo44x 4y ago
      I’ve been saying this for a long time now and none of my Canadian friends seem to understand. I guess they’ve only seen rates continue to drop over the last 40 years. But I think people will be shocked when their interest rate is 10% soon. It sounds unthinkable but it’s the only way to get inflation under control. I expect a massive crash in the Canadian home market. In certain areas that have been high fliers I’d expect 50% - 60% declines or larger. Combine exploding interest rates, high inflation, and banning foreign buyers, the housing market is about to get “cheap” for cash buyers.
- epgui 4y ago
  Most Canadians are extremely over-leveraged, have poor financial literacy, and are more or less YOLO-ing living beyond their means. For most, it’s been more or less working out fine for some time, thus far.
  - ffggvv 4y ago
    that’s every western country
- mijamo 4y ago
  And what about Sweden where people mostly have 3 months rate mortgages and are even more leveraged than Canada? Here sometimes people don't even pay back the principal at all, it's just interests payment every month and waiting for the increase in price to erase your debt. That felt super weird for me coming from France where flexible mortgage rates do not exist. But of course everybody was getting 1% last year, and now it's 1.5% and everybody already feels the difference. If it had to go up to 4% the whole country would be in crisis, and above that well...
  - gspr 4y ago
    Same in Norway. Here, banks are required to deny mortgages to people who they do not see as being able to handle much higher rates than on the date the mortgage was taken. Is that not the case in Sweden? (I personally think they should test for even higher rates – I'm terrified to see how many people are in absolute shock that rates are rising rapidly, after being told that exactly that will happen for years)
    - rnd33 4y ago
      It's the same case in Sweden, all new lenders have to be able to handle rates of 6-8%.
    - kqr 4y ago
      I think you overestimate the sophistication of the models the banks use. There's no reason for them to use honest models. If things turn to shit, the public will bail them out anyway. So the banks may well say "if you spend a minimum on food and clothing, and nothing on anything else, you can afford to pay high rates." But that's not what regular people would mean by affording it.
      - gspr 4y ago
        Fair enough, but that doea still mean that higher rates are factored in. Not just as well/strongly as you and I would like.
  - msh 4y ago
- cperciva 4y ago
  Most Canadians don't even realize that longer term mortgages are a thing. In Canada they were effectively banned in 1880; section 10 of the Canada Interest Act says that if you get a loan for more than 5 years you can repay it early -- effectively meaning that a "10 year mortgage" comes with a mandatory (and very large!) interest rate derivative. Since borrowers don't want to pay extra for that derivative -- and frankly are unlikely to be able to afford it even if they wanted it -- we end up with effectively no market in >5 year mortgages. And yes, this is absolutely terrible public policy; forcing Canadians to take a series of short-term mortgages not only makes the economy far more vulnerable to interest rate shocks, but also creates a significant dead weight loss as homeowners and banks repeatedly churn through mortgage application and initiation paperwork.
  - bradleyjg 4y ago
    In the US all mortgages have an embedded put option. They are nonetheless affordable, because rather than being privately underwritten mortgages are effectively owned or guaranteed by the government, which sets the rates by political fiat rather than economics.
    - sokoloff 4y ago
      I thought only a subset of mortgages were directly backed (VA, FHA, USDA) and that only conforming mortgages were eligible to be sold to Fannie Mae/Freddie Mac, with non-confirming (colloquially “jumbos”) being entirely privately funded. The non-confirming loan share varies widely over time, but is usually double-digit percentage of overall mortgages.
      - bradleyjg 4y ago
        I believe the Fed also owns some non agency mbs. On top of that bank regulators manipulate capital adequacy requirements to make them more attractive to banks than they would be otherwise.
        formerkrogemp 4y ago
ckcheng 4y ago
Related thread: https://news.ycombinator.com/item?id=31692543 https://news.ycombinator.com/item?id=31692543 This is the followup article heavily discussed in that thread.
deleted 4y ago
[deleted]
gerdesj 4y ago
Not all your audience are Cannucks - Your data is beautifully indexed but only related to CAD. It would be helpful if a few pointers to some other well known currencies was provided for scale. I too have this snag quite often being a snivelling GBP user! I haven't read your first article yet so I'll pipe down for now. I note that the graphics of a biplane looks suspiciously like a German WW1 aircraft - the tailfin shape is certainly not a Sopwith Camel or Pup! The way that money works is a fascinating subject. I note that there are far more articles about making money work via investments etc rather than from direct work from the US and CA than pretty much anywhere else. I suppose that's the "dream" thing.
- jbay808 4y ago
  > Not all your audience are Cannucks - Your data is beautifully indexed but only related to CAD. It would be helpful if a few pointers to some other well known currencies was provided for scale. I too have this snag quite often being a snivelling GBP user! Thank you! That's a good point. I'm not sure how to handle it because exchange rates do fluctuate on the scale of decades that my post covers. For example in 2012, the CAD and USD were at par (1 USD = 1 CAD), whereas last year we were down as low as US 0.70 per CAD. If I expressed the Canadian CPI in USD that would look like a 30% deflation. Now we're up at 0.79 USD per CAD one year later. It's pretty volatile. > I note that the graphics of a biplane looks suspiciously like a German WW1 aircraft - the tailfin shape is certainly not a Sopwith Camel or Pup! You are (almost) correct! It's a Fokker D.VIII monoplane. I'm not a spy! I was just looking for a nice clean public domain vector art image of a prop plane in profile on Wikimedia Commons and that's what I found first. Honest!
  - Majromax 4y ago
    > If I expressed the Canadian CPI in USD that would look like a 30% deflation. Now we're up at 0.79 USD per CAD one year later. It's pretty volatile. If you wanted to convert the numbers, over decadal timescales you'd probably want to use purchasing power parity (PPP, or $INT) figures. That tends to be less volatile, and since it reflects the approximate cost of goods and services it's a better intuitive like-for-like match. > I was just looking for a nice clean public domain vector art image of a prop plane Given the topic, I'm a bit disappointed you couldn't get an image of a Japanese Zero. Incidentally, if you're still working on "Inflation, part 2", one way to close the central bank reaction function is to assume a Taylor Rule (https://en.wikipedia.org/wiki/Taylor_rule https://en.wikipedia.org/wiki/Taylor_rule). I've long thought that the Taylor Rule should be interpreted as a kind of PID controller, save that nobody in economics seems to relate the "assumed equilibrium real interest rate" to an integral term.
uptownfunk 4y ago
Maybe I'm not smart enough to understand what is going on here - is there any relevance to US markets (something tells me yes...)? and what is the TLDR if so (I suspect not good)?
- burlesona 4y ago
  The author is building an argument that central bank efforts to combat inflation will (unintentionally and unavoidably) drive inflation UP before they can bring inflation back down, essentially because the cost of housing represents such a large share of assets that mortgage rate increases will have a massive inflationary effect. I didn’t realize until reading the footnotes, but this is largely because in Canada you cannot get a fixed rate mortgage, only a 5 year ARM. So nearly everyone who has a mortgage will be forced to refinance at higher rates over the next five years, and those higher rates will greatly increase their cost of housing.
  - papercrane 4y ago
    You can get long term fixed rate mortgages in Canada, but they're rare and the rates are high. The major in lenders don't typically bother advertising them, instead they advertise rates for 1-7 year term mortgages with various options (open/closed, fixed or APR.)
    - JohnJamesRambo 4y ago
      Why is this different in Canada and USA?
      - papercrane 4y ago
        I'm guessing regulatory frameworks and a more competitive market in the US. It's surreal to me the rates you can get locked in for 25 years in the US. Seems like the lender is taking a lot of risk there. When I first got my mortgage in Canada RBC offered me something like ~2% fixed on a 5 year term or ~8% fixed for a 25 year term. I can't imagine what their 25 year term rate is right now.
epgui 4y ago
I can count on one hand the number of times I’ve intentionally signed up for a newsletter. I’m really enjoying your articles, please do keep them coming.
- xchaotic 4y ago
  Ha, same here - read two articles and signed up. I really like the writing style.
titanomachy 4y ago
The model shows that increasing interest rates while fixing housing prices will cause an increase in inflation, which is interesting because most people believe that increasing interest rates is an effective way to reduce inflation. The accuracy of this analysis is acknowledged to be limited to the five-year mortgage terms common in Canada. But I don’t see a justification for fixing housing prices. If we assume that a decent fraction of people have maximally extended themselves to buy their homes, then when forced to remortgage at a higher rate those people would instead sell and downsize, rent, move in with family, etc. A model which allows demand to change as a function of monthly mortgage cost could yield completely different dynamics. That said, awesome analysis. It was really interesting to learn that home price increases and interest rate decreases have basically perfectly balanced each other to keep mortgage payments flat. And we’ve just run out of interest rate decreases…
- jbay808 4y ago
  Sorry, I just saw your comment now. Not sure if you'll notice this reply. > But I don’t see a justification for fixing housing prices. There is no justification for fixing house prices; that is an assumption made purely to consider the result of that hypothetical scenario, to examine what the consequence would be of housing prices not falling. The reason this scenario is worth modelling is simply because many Canadians do strongly believe that housing prices will not fall, so I want to examine what the world would look like with this belief being correct. I also consider a scenario where housing prices drop by half. If rates keep going up as quickly as they are, I actually think it's plausible that housing prices drop more than this, but I have to pick a number that won't cause readers to simply tune out. The model so far is only a partial model; housing demand is not included, but it could be in the future. Then housing prices would not need to be taken as an input, and could be projected forward. But I'm not sure it's worth the time to build that model; no matter how rigorously I derived it, I don't think it would change anybody's minds. Canadian housing prices are a charged topic and the beliefs people hold are pretty hard to change.
- imtringued 4y ago
  Increasing interest rates causes people to hoard money over the short term but since interest is being reinvested rather than spent this leads to an increase in the money supply over the long term. If you want to stop long term inflation you actually need 0% interest rates or lower for 0% inflation like Japan.

157 points by kristianp 4y ago

How do Canadians feel about the shorter term(5 years) available for fixed rate mortgages? I would think that shorter term would contribute a significant level of anxiety regarding one's future financial solvency.

kevin_nisbet 4y ago
I don’t know that I really count since I’m quite frugal. On my end I think the term mortgages are great since I believe it leads to lower overall interest rates. There’s a lot less risk that gets baked into the price that would be needed for longer terms. I know I’ve compared to other jurisdictions where interest seems way higher. So it doesn’t cause me any anxiety.
- amscanne 4y ago
  It’s been “great” for the last forty years because rates have been consistently trending downwards. You’ve never had to think about the downside. Your experience would/will be much different in an environment where rates are rising. Regarding the upside, the rates aren’t much different in the US where you typically have 30 years locked in. Unlike Canada, these also generally have no prepayment penalty, so you can always refinance on rate drops. I’m quite sure the rates on a ARM 5 year or 8 year would be directly comparable to a Canadian mortgage (and you always have that option in the US). There’s lots of great things about Canada, but I think you’re really stretching to see a positive where there isn’t one. (I’m Canadian but I definitely don’t hold a positive view of our financial institutions.)
  - xyzzy123 4y ago
    30 year mortgages are a political guarantee to homeowners. They're don't really come from the lending industry - lenders could not and would not ever create this product on their own. They're a government subsidy to mortgagors enabled by the origination process, obscured by a few hops of financialization. You get a rate guarantee for 30 years plus you can refi, sell or walk away if the bet doesn't go your way. It's pretty much begging to be exploited.
    - barry-cotter 4y ago
      > They're don't really come from the lending industry - lenders could not and would not ever create this product on their own. I was going to quibble with this since I’ve seen fixed rate mortgages in Ireland but… > A fixed rate mortgage is a home loan for which the interest rate is kept the same for an agreed amount of time. The maximum length of time for which a mortgage can be fixed in Ireland is ten years. https://personalbanking.bankofireland.com/articles/my-first-home/looking/fixed-vs-variable-rate-mortgage/#:~:text=A%20fixed%20rate%20mortgage%20is%20a%20home%20loan,so%20what%20is%20a%20variable%20rate%20mortgage%20then%3F https://personalbanking.bankofireland.com/articles/my-first-...
      - xyzzy123 4y ago
        Yes and the rates will tend to be considerably different - you will actually see a risk premium in the longer terms, as you would expect. The fact that "cheap" 30 year fixed rate mortgages only exist in a few countries (US is only one I know of, but it's a big world) is the most accessible evidence that they're created by government policy (without having to dig into the technical details of how they are originated and guaranteed).
        maxerickson 4y ago
        Living in the US, I can't imagine taking out the maximum mortgage that I theoretically qualify for. (without having done it, I think I don't like the idea of 1/2!)
        denimnerd42 4y ago
        It’s pretty easy to take out the maximum if you’re trying to buy a home without contingency on selling your previous one. Since only the monthly payments really matter towards qualification you could be 90% paid off on your first mortgage and still need to work around the DTI limit for your second. When you sell your first everything becomes comfortable again.
  - kevin_nisbet 4y ago
    I don’t think it’s fair to say I’m not aware of the downsides. Yes my own experience is universally in a very aggressive rate environment that could impact my perspective. But I’m also aware that the majority of the time variable rates end up ahead of fixed rates. The term mortgages to me make it a bit closer to variable rates. The rate gets updated every few years. Banks themselves to fund the mortgages don’t get 25 year loans. So as an institution they need to set rates based on risk so they don’t lose money. This risk increases the further you project into the future. So all other things being equal you are not paying a premium to insure against that risk. I’m not commenting on the financial institutions as a whole, or other factors that may lead to higher or lower rates. I’m under the impression that rates are a higher in the us for the 25 year mortgages when calculated off of the overnight rates from the central banks. But I don’t have any data handy to back up the impression for I could be wrong. I suppose having this be an option for the consumer is probably the best option. But for most consumers insuring against rate increases will be quite costly.
    - happyopossum 4y ago
      > But for most consumers insuring against rate increases will be quite costly. I’m not sure how you can make an argument that long and specific while completely ignoring the evidence to the south of you that contradicts it.
  - deleted 4y ago
    [deleted]
- PragmaticPulp 4y ago
  > On my end I think the term mortgages are great since I believe it leads to lower overall interest rates. When rates are going down, yes. But locking in low rates in the United States for 30 years either at purchase time or via refinancing is one of the weirdest advantages of home ownership here. It's surreal to have a 2.x% mortgage locked in for decades when rates are quickly going up and inflation is reducing the relative value of my debt and payments.
  - pishpash 4y ago
    The only way this ends is by running the process in reverse where declining asset prices reduce the gains made on the debt side. If asset prices do not decrease in a rising rate environment, then inflation cannot be controlled. We've baked in 8% annualized real loss somewhere going forward and it will come out of somebody's pockets, but it's still being decided whether asset owners or debtors will pay.
    - chii 4y ago
      > If asset prices do not decrease in a rising rate environment, then inflation cannot be controlled the asset price could remain stable, if the jobs that service those mortgages aren't removed. Inflation of consumables can be controlled, but it is painful. Inflation of assets should not be controlled, even if it could - asset growth represents the wealth of those who invested in it. If this growth is artificially suppressed, millions would lose their retirement funds, and become poorer in the future, and for what?
      - sjfidsfkds 4y ago
        Inflation means there is too much demand in the economy compared to the supply (of goods and labor). Decreased retirement funds are one mechanism by which asset price reductions can lead to people consuming less and working more. More broadly there’s a wealth effect that determines how much people spend.
      - pishpash 4y ago
        Nothing is in a vacuum and wealth only has meaning relatively. As much as it may be a shock to hear, wealth is but a social contract on how much it gets you in exchange. There is no absolute answer on that and it's subject to negotiation. If you are in charge of distributing wealth (which is what this is, let's be honest), higher prices means current asset holders are favored over future asset holders who want to purchase assets. Why should those who invested in a bubble during the loosest money era be entitled to exchange it for the same amount of labor or goods of those who built wealth during austerity?
- refurb 4y ago
  Leads to lower rates? The US 30 year fixed bottomed out at 2-2.5%, which seems about the same as the lowest 5 year fixed in Canada? When Canadians have to renew at 5-7% in a few years that’s going to cause massive havoc.
  - rnd33 4y ago
    On average over a longer period variable rates will always be lower, since the risk premium due to future rate uncertainty will be lower. If that period is a 100 years it won't help lenders much though.
    - refurb 4y ago
      Variables rates will always be lower? At any given point in time, true. But you can lock in a fixed rate that will be lower than a variable rate in the future when rates rise.
- throwawayarnty 4y ago
  Variable rates are great until rates dramatically increase. A huge number of Canadians will not be able to afford their mortgage payments over the next 5 years because they did not calculate rate rises when buying home. Furthermore, they won’t be able to sell the home without taking a huge loss because housing prices will have plummeted due to rate hikes. Combine that with rising cost of food and gas, Canadians are in for a wild ride.
  - nemo44x 4y ago
    I’ve been saying this for a long time now and none of my Canadian friends seem to understand. I guess they’ve only seen rates continue to drop over the last 40 years. But I think people will be shocked when their interest rate is 10% soon. It sounds unthinkable but it’s the only way to get inflation under control. I expect a massive crash in the Canadian home market. In certain areas that have been high fliers I’d expect 50% - 60% declines or larger. Combine exploding interest rates, high inflation, and banning foreign buyers, the housing market is about to get “cheap” for cash buyers.
epgui 4y ago
Most Canadians are extremely over-leveraged, have poor financial literacy, and are more or less YOLO-ing living beyond their means. For most, it’s been more or less working out fine for some time, thus far.
- ffggvv 4y ago
  that’s every western country
mijamo 4y ago
And what about Sweden where people mostly have 3 months rate mortgages and are even more leveraged than Canada? Here sometimes people don't even pay back the principal at all, it's just interests payment every month and waiting for the increase in price to erase your debt. That felt super weird for me coming from France where flexible mortgage rates do not exist. But of course everybody was getting 1% last year, and now it's 1.5% and everybody already feels the difference. If it had to go up to 4% the whole country would be in crisis, and above that well...
- gspr 4y ago
  Same in Norway. Here, banks are required to deny mortgages to people who they do not see as being able to handle much higher rates than on the date the mortgage was taken. Is that not the case in Sweden? (I personally think they should test for even higher rates – I'm terrified to see how many people are in absolute shock that rates are rising rapidly, after being told that exactly that will happen for years)
  - rnd33 4y ago
    It's the same case in Sweden, all new lenders have to be able to handle rates of 6-8%.
  - kqr 4y ago
    I think you overestimate the sophistication of the models the banks use. There's no reason for them to use honest models. If things turn to shit, the public will bail them out anyway. So the banks may well say "if you spend a minimum on food and clothing, and nothing on anything else, you can afford to pay high rates." But that's not what regular people would mean by affording it.
    - gspr 4y ago
      Fair enough, but that doea still mean that higher rates are factored in. Not just as well/strongly as you and I would like.
- msh 4y ago
cperciva 4y ago
Most Canadians don't even realize that longer term mortgages are a thing. In Canada they were effectively banned in 1880; section 10 of the Canada Interest Act says that if you get a loan for more than 5 years you can repay it early -- effectively meaning that a "10 year mortgage" comes with a mandatory (and very large!) interest rate derivative. Since borrowers don't want to pay extra for that derivative -- and frankly are unlikely to be able to afford it even if they wanted it -- we end up with effectively no market in >5 year mortgages. And yes, this is absolutely terrible public policy; forcing Canadians to take a series of short-term mortgages not only makes the economy far more vulnerable to interest rate shocks, but also creates a significant dead weight loss as homeowners and banks repeatedly churn through mortgage application and initiation paperwork.
- bradleyjg 4y ago
  In the US all mortgages have an embedded put option. They are nonetheless affordable, because rather than being privately underwritten mortgages are effectively owned or guaranteed by the government, which sets the rates by political fiat rather than economics.
  - sokoloff 4y ago
    I thought only a subset of mortgages were directly backed (VA, FHA, USDA) and that only conforming mortgages were eligible to be sold to Fannie Mae/Freddie Mac, with non-confirming (colloquially “jumbos”) being entirely privately funded. The non-confirming loan share varies widely over time, but is usually double-digit percentage of overall mortgages.
    - bradleyjg 4y ago
      I believe the Fed also owns some non agency mbs. On top of that bank regulators manipulate capital adequacy requirements to make them more attractive to banks than they would be otherwise.
      - formerkrogemp 4y ago

ckcheng 4y ago

Related thread: https://news.ycombinator.com/item?id=31692543 https://news.ycombinator.com/item?id=31692543 This is the followup article heavily discussed in that thread.

deleted 4y ago

[deleted]

gerdesj 4y ago

Not all your audience are Cannucks - Your data is beautifully indexed but only related to CAD. It would be helpful if a few pointers to some other well known currencies was provided for scale. I too have this snag quite often being a snivelling GBP user! I haven't read your first article yet so I'll pipe down for now. I note that the graphics of a biplane looks suspiciously like a German WW1 aircraft - the tailfin shape is certainly not a Sopwith Camel or Pup! The way that money works is a fascinating subject. I note that there are far more articles about making money work via investments etc rather than from direct work from the US and CA than pretty much anywhere else. I suppose that's the "dream" thing.

jbay808 4y ago
> Not all your audience are Cannucks - Your data is beautifully indexed but only related to CAD. It would be helpful if a few pointers to some other well known currencies was provided for scale. I too have this snag quite often being a snivelling GBP user! Thank you! That's a good point. I'm not sure how to handle it because exchange rates do fluctuate on the scale of decades that my post covers. For example in 2012, the CAD and USD were at par (1 USD = 1 CAD), whereas last year we were down as low as US 0.70 per CAD. If I expressed the Canadian CPI in USD that would look like a 30% deflation. Now we're up at 0.79 USD per CAD one year later. It's pretty volatile. > I note that the graphics of a biplane looks suspiciously like a German WW1 aircraft - the tailfin shape is certainly not a Sopwith Camel or Pup! You are (almost) correct! It's a Fokker D.VIII monoplane. I'm not a spy! I was just looking for a nice clean public domain vector art image of a prop plane in profile on Wikimedia Commons and that's what I found first. Honest!
- Majromax 4y ago
  > If I expressed the Canadian CPI in USD that would look like a 30% deflation. Now we're up at 0.79 USD per CAD one year later. It's pretty volatile. If you wanted to convert the numbers, over decadal timescales you'd probably want to use purchasing power parity (PPP, or $INT) figures. That tends to be less volatile, and since it reflects the approximate cost of goods and services it's a better intuitive like-for-like match. > I was just looking for a nice clean public domain vector art image of a prop plane Given the topic, I'm a bit disappointed you couldn't get an image of a Japanese Zero. Incidentally, if you're still working on "Inflation, part 2", one way to close the central bank reaction function is to assume a Taylor Rule (https://en.wikipedia.org/wiki/Taylor_rule https://en.wikipedia.org/wiki/Taylor_rule). I've long thought that the Taylor Rule should be interpreted as a kind of PID controller, save that nobody in economics seems to relate the "assumed equilibrium real interest rate" to an integral term.

uptownfunk 4y ago

Maybe I'm not smart enough to understand what is going on here - is there any relevance to US markets (something tells me yes...)? and what is the TLDR if so (I suspect not good)?

burlesona 4y ago
The author is building an argument that central bank efforts to combat inflation will (unintentionally and unavoidably) drive inflation UP before they can bring inflation back down, essentially because the cost of housing represents such a large share of assets that mortgage rate increases will have a massive inflationary effect. I didn’t realize until reading the footnotes, but this is largely because in Canada you cannot get a fixed rate mortgage, only a 5 year ARM. So nearly everyone who has a mortgage will be forced to refinance at higher rates over the next five years, and those higher rates will greatly increase their cost of housing.
- papercrane 4y ago
  You can get long term fixed rate mortgages in Canada, but they're rare and the rates are high. The major in lenders don't typically bother advertising them, instead they advertise rates for 1-7 year term mortgages with various options (open/closed, fixed or APR.)
  - JohnJamesRambo 4y ago
    Why is this different in Canada and USA?
    - papercrane 4y ago
      I'm guessing regulatory frameworks and a more competitive market in the US. It's surreal to me the rates you can get locked in for 25 years in the US. Seems like the lender is taking a lot of risk there. When I first got my mortgage in Canada RBC offered me something like ~2% fixed on a 5 year term or ~8% fixed for a 25 year term. I can't imagine what their 25 year term rate is right now.

epgui 4y ago

I can count on one hand the number of times I’ve intentionally signed up for a newsletter. I’m really enjoying your articles, please do keep them coming.

xchaotic 4y ago
Ha, same here - read two articles and signed up. I really like the writing style.

titanomachy 4y ago

The model shows that increasing interest rates while fixing housing prices will cause an increase in inflation, which is interesting because most people believe that increasing interest rates is an effective way to reduce inflation. The accuracy of this analysis is acknowledged to be limited to the five-year mortgage terms common in Canada. But I don’t see a justification for fixing housing prices. If we assume that a decent fraction of people have maximally extended themselves to buy their homes, then when forced to remortgage at a higher rate those people would instead sell and downsize, rent, move in with family, etc. A model which allows demand to change as a function of monthly mortgage cost could yield completely different dynamics. That said, awesome analysis. It was really interesting to learn that home price increases and interest rate decreases have basically perfectly balanced each other to keep mortgage payments flat. And we’ve just run out of interest rate decreases…

jbay808 4y ago
Sorry, I just saw your comment now. Not sure if you'll notice this reply. > But I don’t see a justification for fixing housing prices. There is no justification for fixing house prices; that is an assumption made purely to consider the result of that hypothetical scenario, to examine what the consequence would be of housing prices not falling. The reason this scenario is worth modelling is simply because many Canadians do strongly believe that housing prices will not fall, so I want to examine what the world would look like with this belief being correct. I also consider a scenario where housing prices drop by half. If rates keep going up as quickly as they are, I actually think it's plausible that housing prices drop more than this, but I have to pick a number that won't cause readers to simply tune out. The model so far is only a partial model; housing demand is not included, but it could be in the future. Then housing prices would not need to be taken as an input, and could be projected forward. But I'm not sure it's worth the time to build that model; no matter how rigorously I derived it, I don't think it would change anybody's minds. Canadian housing prices are a charged topic and the beliefs people hold are pretty hard to change.
imtringued 4y ago
Increasing interest rates causes people to hoard money over the short term but since interest is being reinvested rather than spent this leads to an increase in the money supply over the long term. If you want to stop long term inflation you actually need 0% interest rates or lower for 0% inflation like Japan.